Cover Story: Mavericks In A Maverick Industry

9/28/2009 5:26 PM Eastern

By: by Mike Farrell

It was just about five years ago that Cox Communications said goodbye to the public markets in a $4.9 billion buyout by parent Cox Enterprises, which purchased the remaining public shares of the company it didn't already own. The deal, first announced in August 2004, closed on Dec. 3 of that year.

While Cox's private move was a bit surprising to many in the cable community, a lot has changed in the half-decade since the transaction. The stock market crashed, the banking system collapsed and cable valuations plunged to all-time lows.

Chalk one up for the visionaries. Through that single transaction, Cox has managed to avoid all the fallout from those calamities as well as the wild fluctuations in the market — cable stocks fell 10% in 2005, were up 40% in 2006, but declined 28% in 2007 and fell 22% in 2008 — and instead has been able to concentrate on investing in the business. According to Cox Enterprises CEO Jimmy Hayes — who, as Cox Communications' chief financial officer in 2004, engineered much of the going-private transaction with Cox Enterprises chairman Jim Kennedy — the cable company has been able to pump billions of dollars back into the business in that time frame. Investments made include the upgrade of its cable systems to 1-Gigahertz capacity and its most recent initiative, to build its own cellular telephone network.

In an interview earlier this month, Hayes called the going-private transaction “the single most important move in the history of this company.”

Not only has it allowed Cox to weather the financial turmoil of the past year without the added pressure of having to appease Wall Street, said Hayes, it has freed the company to focus on a long-term strategy for the business. Perhaps nothing illustrates that freedom more than Cox's plans to build its own wireless telephone network, an endeavor that other cable operators have avoided like the plague.

Couple that with initiatives on the video front — such as MyPrimetime TV on demand — the 1-GHz upgrade and its rollout of DOCSIS 3.0, and it's no surprise that Cox Communications is this year's choice for Multichannel News Operator of the Year.

“There's a reason we're private,” said Cox CEO Patrick Esser. “One of the reasons you go private is that you want to do things that have longer-term payback windows than what the public market has a tolerance for.

“We can do the things that we believe are right for the Cox family longer-term, and you have a different set of expectations — there is still an execution requirement, still a performance requirement, still a return requirement, but the owner still has the same understanding that management has.”

Insight Communications chairman and CEO Michael Willner, who took his company private in 2007, said that while Cox wasn't the inspiration for his decision to spurn the public markets, it has been a role model for just about everything else.

“They were more of an inspiration for their operations and their dedication to serving the customer,” Willner said. “Cox was the standard-bearer and always has been.”

Cox began racking up J.D. Power & Associates customer-service awards in 1996 and has consistently been the top-rated cable company in the customer-satisfaction index. This year, Cox for the seventh consecutive year received J.D. Power's highest honor in telephone customer satisfaction in the West region of the country.

Miller Tabak media analyst David Joyce, who followed Cox when it was public, said those customer-service awards and the way Cox continues to do business make it a leader in the industry.

“They still are the gold standard,” Joyce said. “It's a very well-regarded cable operation.”

Joyce pointed to Cox's pioneering telephony rollout in 1997. The MSO weathered a lot of early criticism, but the launch ultimately laid the groundwork for one of the industry's most successful products.

“They have been a maverick in a maverick industry,” Joyce said.

That maverick quality is rearing its head again with Cox's decision to launch and build its own wireless-telephone network when others are concentrating on data. While the company is aware of the risk — it will have to go up against well-established and entrenched providers like AT&T, Verizon Wireless, Sprint Nextel and T-Mobile — Esser said wireless is far from a bet-the-company move. For starters, Cox has retained its relationship with Sprint Nextel to provide infrastructure in markets where a build-out is not feasible.

“This is not a make-or-break bet,” Esser said. “It's a big bet for Cox, but mobile could be a big part of the business.”

The CEO added that while the wireless venture is a lot for the company to chew on — it includes establishing retail locations, choosing handsets and other consumer devices as well as physically building the network — the idea is the work will pay off in much greater future dividends.

“This is a transformational change; there isn't a part of our business that doesn't get touched,” Esser said. “On the flip side, it will enable us to transform our business. Wireless is a bits play. It allows you to move more commercial services across the platform. You just have to do it in the most efficient way to make the applications work for you.”

Estimates are that Cox will eventually pump $1 billion into the cellular initiative — it spent about $550 million buying cell licenses in the 2008 federal spectrum auctions alone.

While some skeptics have criticized the company for devoting a hefty chunk of capital for a business that is essentially a commodity, Cox takes those barbs in stride.

“Thirteen years ago, we got into wireline telephone and everyone questioned the intelligence of doing that,” said Dallas Clement, Cox executive vice president and chief strategy and product officer. “Today, we have 28% penetration of wireline telephone and, in six markets, we have larger market share than the [incumbent local-exchange carrier]. That has been hugely successful and it was the foundation for Cox business services.”

Those skeptics also are missing a key element of the wireless equation, he added.

“If I want the customer to change to me, I have to have a credible complete offering, which includes voice,” Clement said.

Cox does not enter the voice markets blindly. Despite its ultimate demise, the Pivot wireless telephone venture — which involved Cox, Comcast, Time Warner Cable, Bright House Networks and Sprint Nextel — may not have been a rousing success, but it was a learning experience, at least for Cox.

One lesson learned: Take a centralized approach to the rollout to ensure uniformity of product, message and service. On that tack, Cox created its own center for excellence in Oklahoma City, where general managers from each market could learn from one another the best way to offer the service.

“We conformed all of the operating parameters for wireless,” Clement said. “[For example with] credit scoring, 'San Diego, sorry that you have a different one than Phoenix. Let's all get in a room and hear your thoughts, but we're going to come out of the room with one perspective.' We did that. That was hugely successful in terms of our ability to quickly roll out new markets.”

Despite the lessons learned from Pivot, Cox decided to sit out the next cable wireless consortium — the wireless-data joint venture with Clearwire. Clement said there were several reasons for passing on Clearwire, including its desire to focus on voice (the JV is centering on Wi-Max data service) and the usual difficulties that surface when several cooks attempt to make soup.

Still, Clement believes the rest of the industry is cheering on the sidelines for the Cox wireless initiative, if only that its success could mean yet another product arrow for cable's quiver.

“With wireless, we can be different, and that doesn't impinge on the overall opportunity,” Clement said. “I think Comcast and Time Warner Cable are absolutely eager for us to succeed, because they know if we succeed it gives them options and they know that we will be happy to share whatever learnings that we have.”

Cox's decision to sit out the Clearwire partnership did not signal an aversion to industry consortiums. Cox is an active member of the Canoe interactive advertising initiative, working closely with Comcast, Time Warner Cable, Cablevision Systems, Charter Communications and Bright House Networks.

“The value of Canoe is getting MSOs to do everything the same,” Clement said. “If we don't offer the same capability, the same offering, an easy way to buy it such that Procter & Gamble can do it one way, Procter & Gamble is not going to buy this platform …

“The big opportunity and the way you get the big guys to play is to do it consistently. There continues to be a commitment to do that.”

While Cox is on the cutting edge of wireless and interactive advertising advances, it has decided to take a wait-and-see stance regarding Internet TV and the move towards authentication, which is being spearheaded by Comcast and Time Warner Inc.'s TV Everywhere initiative.

Clement said that there is no need for everyone to conduct TV Everywhere trials just yet, but added that it isn't always necessary to be in the vanguard.

“We're OK not being the product innovators. You have to be within spitting distance of the competition, but you don't need to be the lead,” Clement said, adding that on authentication, Cox is going to be a “fast follower.”

“You're not going to see us lead the industry on that,” he said. “We believe that MyPrimetime and the on-demand environment is more relevant to customers to watch TV.”

That said, Cox has been aggressive on the technology front — its five-year upgrade program, dubbed EON (Extendable Optical Network), is winding down this year, with most of its systems now at 1 GHz of capacity. The initiative has put Cox in an enviable position — unlike some of its peers, Cox isn't scrambling to find additional bandwidth for HD, high-speed data and VOD offerings. The company already offers more than 130 HD channels in most markets (Comcast and Time Warner Cable have struggled to reach 100 HD channels), has more than 7,500 VOD titles available to customers and offers high-speed data at speeds of up to 20 Megabits per second with its PowerBoost premium service. Those speeds will rise even higher with the rollout of DOCSIS 3.0, which has already occurred in several markets. Cox is aiming to have the technology available in two-thirds of its footprint by the end of 2010.

While the upgrade of the systems nears completion, the number of operational areas has dwindled as well. In April, Cox pared its operating systems to 14 locations; as part of the consolidation, Baton Rouge, Lafayette and New Orleans, La., were combined into the Greater Louisiana territory under Jacqui Vines; Central Florida and Gulf Coast were combined under former Gulf Coast general manager Keith Gregory; and California operations, except for San Diego (Orange County, Santa Barbara and Palos Verdes), were merged under Duffy Leone. Cox also consolidated its Hampton Roads/Roanoke, Va., systems under general manager Gary McCollum.

Leo Brennan, Cox executive vice president and chief operating officer, said that the consolidation was made to streamline the operations and save resources. The units also are more standardized under the new regime, which enables them to react more quickly to marketplace changes.

“The big benefit we're going to get out of this standardization initiative is just the fact that when we go to market, we're only going to do it one time, not 14,” Brennan said.

But even a streamlined organization wasn't enough to beat back one of the worst recessions in U.S. history. Cox's largest markets — Phoenix, San Diego and Orange County, Calif., and Las Vegas — were hit hardest by the housing slump.

According to RealtyTrac, a foreclosure database, San Diego and Orange County were Nos. 4 and 5 among California communities for foreclosures in August, with 6,717 and 5,944, respectively. Phoenix's Maricopa County and Clark County, Nev., (home to Las Vegas) had 12,862 and 14,940 foreclosures in August.

“Where those markets were growing like crazy, the housing market just stopped,” Brennan said. “Sure, that has had an impact on us in terms of softness on the growth we expected. By the same token we know this is not a long-term issue, it's going to be short-term, so we want to manage our way through it.”

Cox is doing that with retention marketing, offering discounts to customers where applicable; encouraging them to downgrade service rather than disconnect; and identifying cost savings that can be implemented without affecting the quality of service.

“The economy will pull out of this; things will get better,” Brennan said. “And when they do, those markets are going to be great growth markets again for us.”

Brennan said Cox has been focusing heavily on base management — maintaining and growing its customer base — and though it has suffered basic-video customer losses, just like its peers, it is stepping up customer-retention efforts and dedicating more resources to marketing.

“We have been a connect machine over the years; we're seeing a lot more focus and bringing a lot more people on the customer retention side of the business to keep customers from going out the back door,” Brennan said. “There is a focus on life-cycle management and base management — what do you need to do to make customers feel comfortable with what they have, and how do you get them to the point where they want to stay with you for a long time.”

That focus tied into yet another customer initiative at Cox, called “Trusted Provider.”

Esser said that the concept evolved from Cox's commitment to customer service and is based on five basic tenets, which include: ensuring a quality customer experience; making products work in an easy, intuitive way; keeping products relevant and performing like others in the market; and making sure that they're reliable.

“If you get those things right, you build trust; you can't help but build it,” Esser said.

The fifth and final piece in the trust-building initiative is offering products at a fair price and a good value. That's been difficult as competition has grown and programming costs have risen exponentially.

Programming costs have risen by about 10% at Comcast and Time Warner Cable, and while Esser would not give a specific figure, he said that Cox's programming expenses have been on the rise and that in the past, many operators have had to absorb much of that cost. That is becoming increasingly harder — Cox has averaged rate increases around 5% over the past few years.

“In most cases we are passing on the increases [to customers], because the margins are squeezed so hard in that business; we're at the place where you have to start passing it on,” Esser said.

But that isn't forcing Cox to jump on the programming bandwagon itself. In fact, the Atlanta-based MSO is taking the opposite tack.

In 2007, Cox sold its 25% interest in Discovery Communications in return for $1.28 billion in cash and the Travel Channel. This past June, Cox hired Goldman Sachs to investigate strategic opportunities for Travel, including a possible sale, after receiving several inquiries from outside parties. The auction for the Travel Channel is in its early stages — and Cox reportedly wants to keep a 35% interest in the network for tax reasons — but all indications are that the sale is drawing strong interest.

Esser did not want to comment on the auction, but the possibility of a sale would mean that Cox's programming assets would fall to two regional sports networks (in San Diego and New Orleans) and a handful of news channels in its markets that are basically rebroadcasts of the local nightly news. Cox doesn't seem to have the hunger or need for additional programming that some of its peers have expressed — Comcast, in particular, has said it would look to acquire programming at the right price.

“Our general strategic direction would not be to get deeper into programming,” said chief financial officer Mark Bowser. “Unless you get a lot of scale, it's a tough game.”

Esser said that Cox does not see a burning need for more programming and that the news channels have provided an additional benefit — they have eased retransmission-consent negotiations a bit with some broadcast stations.

Esser would say that he would part reluctantly with the Travel Channel, mainly because he believes there is a tremendous amount of upside remaining at the network.

“Properly nurtured, this asset could achieve a lot of things,” Esser said.

That is a recipe that Cox has followed throughout the years — nurturing assets properly, taking risks when appropriate and maintaining a long-term view of the business and industry. It's an ethic that has helped fuel Cox's success and its stature within the close-knit cable community.

“I think they often see opportunities that others miss and pursue them more aggressively without being overly concerned what others think,” Insight's Willner said. “I applaud them for that and I think the rest of the industry has learned a lot from them.”

BY THE NUMBERS
Cox Communications last filed public financial documents in 2005. A comparison of some key metrics from that report and analyst estimates and company releases for 2008:

Dec. 31, 2005

Dec. 31, 2008

SOURCE: Company filings and reports, analyst estimates and Multichannel News research. *Includes 940,000 subscribers that Cox agreed to sell to Cebridge Connections (now Suddenlink Communications) in October 2005. The deal was closed in early 2006.